Answer to Question 1
The demand for loanable funds reflects the willingness of firms to borrow the money that they need to launch new investment projects, such as building a new factory or overhauling the equipment that they use for production. Most firms do not have the funds internally in retained earnings to finance these projects, so they must borrow them. Firms undertake these ventures in order to earn profit. Each of these projects has a rate of return. It is profitable for a firm to undertake a project as long as the rate of return of the project exceeds the cost of borrowing, or the interest rate. That is, if a firm expects to earn a 12 return on opening a new factory, the project will be profitable if the firm can borrow the funds at a rate less than 12. As the interest rate falls, more investment projects become viable for the firm, so as the interest rate falls, the quantity of loanable funds demanded rises because the firm requires more loanable funds to invest in these newly profitable projects.
Answer to Question 2
The answer is often no. In a differentiated product market, the products offered by different firms are close but not perfect substitutes. In such a market, firms need to account for consumers' willingness to substitute among products. By reducing the price of its products or engaging in a price war, a firm may not be able to capture the entire market. Since the products are not exact substitutes, some consumers may continue to buy products sold by other firms at relatively higher prices.
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